Warren Buffett swears by the inexpensive strategy of investing in low-cost index funds tracking the S&P 500. He encourages this type of investment over active funds in particular. That’s because index funds typically have lower fees and it’s difficult for fund managers to consistently outperform. Moreover, the S&P 500 has returned a historic annualised average return of 11.88% over the last 65 years through bull and bear markets.
Buffett even put his money where his mouth is. He bet that the S&P 500 would outperform a portfolio of five active funds over a 10-year period from January 2008 to December 2017. Of course the Oracle of Omaha was correct. The five funds averaged a return of only 36.3% net of fees. Comparatively, the S&P 500 returned 125.8%.
The index’s recent performance isn’t so strong. In fact, the returns have been miserable in the last year. It’s down 18% in the last 12 months and 23% year to date. So is the S&P 500 still a safe investment for me?
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Empires rise and fall
Today, US stocks make up over 60% of the global stock market. Some 17 of the largest 20 companies by market cap are American. Indeed, it’s difficult to imagine a world in the short-to-medium term where US equities aren’t so dominant. However, in the 1980s, it was Japanese stocks that dominated the investment landscape.
In 1989, Japan accounted for 45% of the global stock market. Then, as the asset bubble burst and monetary policy tightened, Japanese equities plunged over 80%. Over 30 years later, the Nikkei 225 stock index still hasn’t fully recovered. Japan makes up just 6% of the global stock market today. Could the S&P 500 suffer a similar fate to the Nikkei?
I don’t believe so. Yes, the US and Japan face similar challenges such as ageing demographics and increased global competition. However, the US has a more open economic system. This allows for faster population growth and the inflow of the best and brightest from around the world.
Patience is a virtue
Back to my original question of whether investing in the S&P 500 today is a safe strategy. Inflation and interest rates continue to rise. Meanwhile, there’s no end in sight for the war in Ukraine. I fear that we haven’t seen a bottom yet and the bear market could continue for months and even years.
That doesn’t discourage me from investing in the index however. The longer my horizon, the less risky my investment should be. Throughout history, saving regularly through difficult market periods has ultimately rewarded investors. A longer holding period also allows me to benefit from the magic of compounding. Assuming a 10% average annual return — lower than the historical average — I could double my money in around seven years. In 30 years, an investment of £100 a month at this 10% return would leave me with around £210,000. I think my future self would be very thankful for that!
I have to accept that weak returns could continue though and I might even lose money.
And even assuming I make money, the S&P 500 index isn’t an opportunity to ‘get rich quick’. Instead, decades of historical data suggests that regular investments in it and a long-term horizon is likely to reward me as a patient investor.
